04 Jan 2022

What to look out for when entering into arbitration agreements with sovereign states

National law will generally uphold agreements between private parties and states, but care must be taken, explain Kristina Fridman and Michael Jaffe 

national flags of various countries flying in the wind

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When entering into an arbitration agreement with a sovereign state, a private party may encounter issues not otherwise applicable in commercial arbitration agreements solely between private parties.

One common example is when a state enters into an arbitration agreement, but later attempts to disavow the agreement by alleging, inter alia, that the government entity that concluded the arbitration agreement did not have the authority to do so or it is otherwise invalid pursuant to domestic law. G. Born, International Commercial Arbitration 772 (3d ed. 2021) ('Not infrequently, states attempt to disavow their international arbitration agreements, citing national constitutional or legislative provisions restricting the power of government entities to conclude binding arbitration agreements.').  

While many jurisdictions have abolished limitations on the capacity of states and their instrumentalities to agree to arbitration, some jurisdictions still take a restrictive approach. Id at 772. The United States is a notable example because the US generally cannot enter into enforceable arbitration agreements with private parties unless clearly authorised to do so by statute. See US v Shaw, 309 US 495, 500-502 (1940) (only Congress may waive sovereign immunity by statute and consent for the US to be sued); see also 56 Fed Reg 55195, § 1(c)(3) (1991) (generally prohibiting federal agencies from entering into binding arbitration agreements). 

Finnish case

In A v Republic of Finland/Ministry of Justice of Finland, District Court of Helsinki, Case No. L 19/20225, Decision No. 21/41585, 31 August 2021, the Finnish courts recently considered the authority issue. There, the minister of justice, in his official capacity, signed a document consenting to the jurisdiction of the Permanent Court of Arbitration (PCA) for disputes 'concerning the taxation and recovery measures against A and his companies….'  However, when A filed a request for arbitration with the PCA, Finland objected. A applied to compel Finland to arbitrate. Finland raised several objections, including that the minister of justice did not have authority to consent to arbitration, did not do so properly, and that the claims were not arbitrable under Finnish law. 

The district court held that A had justifiable reason to believe the minister of justice acted within his competence and that 'failure to comply with preparatory procedures in a state body required by applicable regulations does not have significance when evaluating whether A has been entitled to trust the validity of the consent.' Nonetheless, the court invalidated the consent, finding it ambiguous.  

Other approaches

On the other side of the spectrum are courts and tribunals that have concluded that a state cannot rely on its own domestic legislation to invalidate its own arbitration agreement. G. Born, International Commercial Arbitration at 774-777. In reaching this conclusion, courts and tribunals have applied one of three approaches: (1) they neutralise the legal capacity issue by applying 'corrective factors', such as reasonable reliance or estoppel; (2) after a choice of law analysis, they apply a different law rending the restriction irrelevant; or (3) they treat the issue as one of subjective arbitrability and find that the 'substantive rule of the law of international arbitration that requires state parties to honour their arbitration agreements' precludes reliance on national law. T. Cheng and I. Entchev, State Incapacity and Sovereign Immunity in International Arbitration, 26 S. Ac. L. J. 942, 954 (2014).

On balance, where a private party is contracting with a sovereign, it would be prudent to ensure that the sovereign counterparty signing the contract containing the agreement to arbitrate has the requisite authority to agree to the implicit waiver of sovereign immunity.  

Kristina Fridman is a New York-based associate at Pillsbury specialising in international arbitration and Michael Jaffe is a disputes partner based at the firm's Washington DC office

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